Turning point for our market?

The 9% fall on the ASX since September confirms the localised weakness in our market and the charts suggest further concerns.

Summary: Traders using a conservative strategy only stay in shares when an index’s medium-term trend line is above its long-term trend line. This approach delivers better returns over time with less downside risk. The strategy offers different approaches to different countries, which is worth keeping in mind as the world divides into net resource importers and net resource exporters.

Key take out: A conservative market timing strategy triggered a sell signal on the All Ordinaries last week.

Key beneficiaries: General Investors. Category: Economics and investment strategy.

After enjoying a share rally for 27 months, conservative traders who use a 50/250 day moving average trend line crossover strategy (see Keeping it simple is not stupid, March 21) last week abandoned the Australian stock market.

Investors who practice this strategy enjoyed the boom leading up to 2007 and then avoided the worst of the bust in 2008. They then caught half the bounce back in 2009 before getting slightly whipsawed in 2010. The correction of 2011 was largely sidestepped before catching the rally early in 2012.

I myself use a more sophisticated market timing strategy that gets me back in rallies faster that shown above, but I won’t complicate the story by telling you how to do that since the focus now is on exiting (not entering) the local market.

Conservative traders only stay in shares (through an exchange-traded fund like the SPDR S&P 200 fund) when the All Ordinaries share index’s medium-term red trend line is above its long-term blue trend line. When the red line dips below the blue line, these conservative traders sell shares and retreat to the safety of a cash management account. This approach delivers not only better returns over time, but with less downside risk. I favour conservative trading, not to speculate, but to avoid gut-wrenching market volatility.

Here is a close-up view of the above chart for the last three years so you can see more clearly how the crossover strategy has worked in practice.

The burning question now is whether the tipping point of last week marks the start of another correction or crash or just a whipsaw. The All Ordinaries index is already down 9% since last peaking on September 2 so if it breaches the 10% mark that will count as a “correction”. But it will have to fall 20% to be considered a “crash” (see A correction coming?, September 10).

It’s worth reviewing what’s happening in other stock markets around the world to see if Australia’s “death cross” with the 50/250 day trend-lines is evident elsewhere.

Across the Tasman the New Zealand 50 index is still on an uptrend and behaving more like the S&P500 than the All Ordinaries. New Zealand is enjoying the fruits of major fiscal and structural adjustment so is riding high in the world. Though it’s strong in agriculture, it’s got scant mining and energy resources.

Applying a conservative trading strategy to America’s S&P 500 index in the last 10 years shows a very simple pathway – first selling to stay out of the worst of the 2008 crash, secondly buying to take advantage of the rally between 2009 and 2011, thirdly being whipsawed in the correction of 2011-12, but then early in 2012 embarking on the stairway to heaven. Though the share index has dipped recently it is still far off a sell signal on a conservative crossover strategy.

China, like other countries, recovered partially in 2009, but then underwent a gradual slide until mid- 2014 after which it displayed a meteoric rise. The conservative trading strategy got in early on that rally.

Hong Kong’s journey has been the most mixed of the major exchanges. Here a conservative trading strategy did well until September 2011 after which it suffered repeated whipsaws. But at present it is still on a buy signal.

Japan’s story is one where conservative traders excelled between 2004 and 2010. From 2010 to 2012 whipsaws ruled, but then a “golden cross” happened and it’s been a profitable blast off since.

The British stock market was profitable for conservative traders up to 2011, but then whipsawed until 2012 after which it enjoyed a nice rally. In mid-October it experienced a sell signal which looked like it would be a temporary pullback, but now it’s become a correction.

Germany also had a conservative trading sell signal in October, but reverted to a buy signal in November after the market snapped back. Recent weakness has not yet generated a sell signal.

So there you have it – a quick Cook’s tour of how conservative traders using the 50/250 day moving average trend lines crossover strategy have fared in the major stock markets of the world.

It is noteworthy that the current market turmoil is not as globally synchronised as was the crash of late 2007 and the correction/crash of 2011. This means the latest sell signal in Australia could prove to be just a whipsaw.

On the other hand the Australian All Ordinaries index resembles the iShares MSCI emerging markets index fund (IEM). That’s not surprising given that Australia is a resource-rich country like many frontier economies. But the worrying observation is that the 50/250 crossover strategy has triggered a sell signal on the All Ordinaries, yet still remains on a buy signal on IEM.

The world is dividing into two blocks – net resource importers who are enjoying the fall in the price of coal, iron ore and oil (e.g. New Zealand, America, China, Germany and Japan) and net resource exporters that are felling the brunt of an income recession (e.g. Australia, Canada, Russia, Brazil and the Middle East).

Australia’s All Ordinaries index normally steers a path between the S&P 500 and the Shanghai Composite, but no more.  For the last year both America and China have shot for the stars, but Australia has shot itself in the foot.


Percy Allan is a director of MarketTiming.com.au. For a free three week trial of its newsletter and trend-trading strategies for listed ETF funds, see www.markettiming.com.au.